The held-to-maturity book is exempt from marked-to-market valuation, implying that securities kept in these portfolios do not run the risk of incurring treasury losses. Edited excerpts:
A lot has been said about the RBI’s latest policy, the MPC minutes and the current liquidity strategy. Some parts of the bond market may be viewing the variable rate reverse repos as a clear sign of starting the process of normalisation. How do you view this?
Going by market reaction, it appears that these steps (by the RBI) were affecting liquidity, though there was not much of a price impact later on. The RBI is clear in its view that in the April-June 2022 quarter, inflation will taper down to 5.25%. Given that outlook, I do not see this policy any different from the previous one.
RBI had a single vote of dissent to its latest monetary policy, which had more to do with the accommodative stance. The same MPC member had dissented last year, when the Governor had said that RBI would maintain its accommodative stance for more than a year.
The discussion, which started after the minutes, was about two things.
First, you have the repo rate. But owing to excess liquidity, it is the reverse repo rate which has become the operative rate. The MPC does not have any power over the gap between the repo and the reverse repo rate. There was some talk about bringing the reverse repo under the committee’s power or that it should be a part of the Governor’s statement rather than that of the MPC. That is how we read it.
Second, if you look at commodities like metal, apart from supply side disruptions, there are geopolitical disruptions as well. China has decided to bring down its emissions dramatically. For example, it has stopped exporting aluminum, which has pushed up prices.
How will something like this come off if you raise interest rates and reduce some aggregate demand at the margins? Is that a priority for the government today? The answer is no. People are jittery that rates can head only one way – higher and higher. No one is disputing that fact.
But one thing is certain. Sustainable economic growth is a priority for the RBI. High inflation is the result of supply side disruption, such as freight cost. Globally, whether it is India-US or China-US, the freight rates have gone up by around five times and even at that price point, you don’t have enough containers available. Moreover, the supply side disruptions are skewed. While the larger companies have recovered, the smaller MSMEs are yet to go into full operational mode. So inflation will not subside till the supply side constraints are resolved.
But, when we in India talk about GDP etc., where is the GDP growth? GDP numbers are rising and so is the stock market. But where is discretionary spending? From that perspective, we have to be accommodative. Over a period, the monetary policy can only achieve so much. There has to be support from the fiscal side as well. But whatever the fiscal side does, it needs to be supported by the monetary side.
Globally, bond markets are navigating the tricky path of growth/inflation picking up while the narrative among policymakers is when to normalise. In India too, perhaps it is the bond market which has the most trepidation when it comes to tighter policy. Is this justified, in your view?
There are a few parts to this question.
We have a limited bond market with a small number of players. The US is a very different market. Initially, even the US bond market was such that there would be intervention whenever the line set by the Federal Reserve was challenged.
In India, there are some doubts about where inflation is heading. As long as RBI is involved, we will look at inflation up to a particular level. We have a limited number of players and, therefore, demand-supply dynamics need to be matched every year. Indian bond traders are not convinced that inflation is temporary. I think inflation will inch up. But it will taper down in the medium term as things become normal both on the demand and supply side.
Having said that, there are no geopolitical risks to inflation; there are risks to inflation from protectionism. But that is unpredictable. The only thing we can do is reasonably make future assumptions based on today’s scenario.
Where are you seeing the 10-year bond yield heading over the near-term?
For the next month, we expect the 10-year bond yield to be close to where it is now. The short-end rates may get affected but from what we have seen in the Indian bond market, when the rates go down, everything tends to get affected.
Which part of the bond yield curve would you recommend at the current juncture?
The real short-end is a better bet i.e. until the US bond market tapers down and the conditions normalise. The long-end may also react, but it will subsequently stabilise.
Most market players in India are mark-to-market ones. That is why they would prefer to keep short-end bonds of up to three years. We have a shortage of real, serious long-term investors who don’t have to worry about mark-to-market.
Taking the question on marked-to-market forward, the RBI, over the past couple of years has been giving dispensations on HTM. Is there more that the central bank can do on that front?
The Held-To-Maturity (HTM) dispensation is the need of the hour and giving it for a short span of one year or six months doesn’t work. A longer timeframe is a must. Because then, in three years, even if the yield goes up by one percentage point, you don’t really lose money. You will make a 2-2.5% carry for two years, and that will take care of the extra five-rupee factor. But unfortunately, we are taking baby steps. Last year, we had up to one-year extension and then we had another one-year extension.
The market demand will keep it so till 2024, because the borrowing is not going to come down till that time. One risk is political. While we have general elections in 2024, we also have big state elections between now and then. This will have some implications. One positive factor is that fuel cess can be reduced and that can soften the impact on inflation, as the MPC has also hinted. The MPC did not say it would be due to the elections; they mentioned the tax structure on fuel.
The RBI started doing Operation Twist in December 2019 as a way to flatten the yield curve. However, if one looks at say spreads between the 5-year bond and the 14-year bond, the curve is still quite steep. What can be done to resolve this issue?
I believe that a steep curve is good because it will retain long-term investors. But unfortunately, the focus is mainly on the benchmark.
With Operation Twist – or OMO or G-SAP – RBI made an attempt towards non-benchmarks. However, there is a technical issue with that. If you sell to RBI, then you can do so from your HTM book. So while RBI is trying to support the market (by even trying to do non-benchmarks), banks resort to profit booking from their HTM books. When your aim is profit booking, then you don’t bother even if the market is at 99.50; you will offer it at 99.20 to RBI. And that does not help the apex bank’s agenda. If they find a way to address this issue, it will solve some of their own burdens when it comes to managing the yield curve.
I cannot agree more with our esteemed governor that the yield curve is a public good, and hence let us all support it.
You have witnessed plenty of cycles in the bond market. In this particular one, how does a trader make money?
One has to be tactical. If you look at it, the bond market has largely been flat of late, maybe 2-3 basis points higher. Many traders have made money and for that you have to be technical in your approach and be in the market. You need to pick the right curve and the right security.
Overall, I am not bearish the way most people are. One can make money in the market only if one is convinced of the opportunities offered by the yield curve.
Let’s look at it this way. When the markets fall, everything including good stocks fall. But the good stocks always recover quickly.
